The mortgage industry is becoming increasingly worried that if risk retention language for MBS in a new bill from Sen. Chris Dodd is not clarified, nonbanks could disappear, the nation's megabanks will get even larger, and consumers will have fewer retail choices.

In particular, mortgage bankers fear that a 5% risk retention requirement will apply to all loans, particularly "A" paper credits guaranteed by Fannie Mae and Freddie Mac, which currently account for 70% of all fundings.

The capital requirement could force small- to medium-sized lenders to either exit mortgage lending/servicing entirely or become correspondents for Wells Fargo, Bank of America and JPMorgan Chase, the three largest players in residential finance.

"This will cause a huge rollup of mortgage bankers," one former MBS trader said. "At a time when the government wants to prevent 'too-big-to-fail' they will be creating more of it. The big banks will be in charge."

The Community Mortgage Banking Project, a trade group headed by former mortgage insurance executive Glen Corso, says the new Dodd bill "needs a clear exemption for well underwritten, lower-risk traditional loans." The senator's financial regulatory overhaul bill requires securitizers to retain at least 5% of the credit risk when loans are packaged into bonds.

The legislation that Dodd will mark up next week allows federal banking regulators and the Securities and Exchange Commission to reduce the risk retention on loans that exhibit high-quality underwriting.

However, the direction given the regulators seems to be very vague when clarity is needed, one source said.

Industry groups are urging the lawmakers to create an exemption for 30-year fixed-rate mortgages and other "qualified" loans.

But the Dodd bill does not provide such a blanket exemption. The regulators also have the discretion to require originators to retain a portion of the credit risk.

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